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People try to diversify among different asset classes to provide portfolio protection during down times. However, this financial crisis disappointed many investors, because almost all assets went down together.

“Correlation” is how two securities move in relation to each other. It is a growing trend that assets are more correlated than before. According to CFA Institute Conference Proceedings Quarterly June 2009 issue, the correlation of MSCI EAFE (Europe/Australasia/Far East) index with the S&P 500 since 1970 is about 0.7; since 1990, it is more than 0.8. In other word, they are highly correlated.

In today’s uncertain markets, diversification is the key. After all, investors should not have all of his/her eggs in one basket. I ran the correlation between SPY and the top 100 ETFs (by net assets) since their inceptions . Daily ETF prices are from Yahoo Finance as of 07/17/09.

Below are some of them. As you can see, the correlation between SPY and EFA since its inception (which was around 9 years ago) is 0.96.

Most of the ETFs I picked have been in the market for more than 5 years (with the exception of SLV). Even bonds (AGG, TIP, TLE) are having positive correlations with SPY, though they are much lower than other equity ETFs.

As I highlighted in the table above, GLD has negative relationship with SPY. In other words, they tend to move in different directions.

According to Matt King, managing director of credit products strategy of Citigroup, we are looking for a 40% increase in government bond issuance in Europe in 2009 and a 140% increase in issuance in the US. Over 50% of US debt is held overseas, particularly by China and sovereign wealth funds. When they start to get concerned about future inflation eroding the value of their holdings, they might stop buying US bonds.

But when that happens is anybody’s guess.

Disclosure: I have long positions in EEM, EFA, SPY, TIP.

Source: Portfolio Diversification Is Key: Consider These ETFs